Of all the bizarre events that have confronted the financial world in this dreadful fall, few say as much about the present state of the industry - and where it's headed - as October's battle between Citigroup and Wells Fargo over the remains of once-proud Wachovia. Citi bid first - a $2 billion, government-assisted offer for the Charlotte company's banking operations; Wells trumped it four days later with a $15 billion offer for all of Wachovia - including its brokerage and asset-management shops - with no government help.
On the surface, neither offer made much sense. As with Washington Mutual, Merrill Lynch, Lehman Brothers and numerous other big-name financial institutions before it, the survival of Wachovia, the nation's fourth-largest bank, was in doubt. By Citi's estimates, its balance sheet boasted $312 billion in toxic mortgages, many of them dicey option ARMs in California inherited as part of its ill-fated 2006 purchase of Golden West Financial. Wells has projected the losses on the portfolio at $74 billion. Yet for all its asset troubles, Wachovia possessed loads of what, especially in today's trying times, has become the most-prized commodity in banking today: Deposits - some $400 billion of low-cost funding, stashed in customer savings, checking and CD accounts, and gathered through a 3,300-branch distribution network. In a world awash with liquidity concerns, nothing-not even capital or a balance sheet loaded with troubled loans-seems to count for more. "Today's credit and liquidity crunch underscores the importance of funding for leveraged institutions," says Andrew Senchak, vice chairman of investment bank Keefe Bruyette & Woods. "And especially in this kind of environment, deposits are by far the most secure form of funding."
That made Wachovia look like a gamble worth taking for Wells, which after a week's worth of squabbling and negotiation - and a Citi pledge to sue for damages - walked away with both the good and bad of Wachovia's operations. Whether or not that means it's the "winner" will depend on the severity of the crisis in general, and Wachovia's problems in particular. But CEO John Stumpf was clearly excited, calling the new Wells a "deposit dynamo," with more than $700 billion in deposits and 6,675 branches in 39 states.
Somewhat lost amid the recent noise of emergency bailouts, failures and desperation deals is that the industry's competitive lines are being redrawn in ways that promise to impact the industry landscape and profitability for decades to come. "We're watching history being made in a way that hasn't happened in a century," says Seamus McMahon, a financial services partner with Booz & Co. in New York. "This is a 100-year storm that carries the potential for profound change."
Nowhere is that more evident than with deposits. As the industry lurches from one asset-inspired crisis to the next, the profile of the assets' balance-sheet alter ego has been elevated significantly. Deposits have become at once a barometer of customers' confidence in a financial institution, and in some cases, the key determinant to its survival. Investors have assigned higher valuations to those banks with the strongest deposit concentrations; those banks in turn are leveraging their funding advantage to cherry pick good lending customers and get stronger.
"One thing we've seen in this crisis is that banks that have large retail deposit bases do well, because retail deposits-particularly when they're insured-are much stickier than wholesale funding," said Federal Reserve Chairman Ben Bernanke in an October speech.
The unspoken corollary is that a bank that begins losing its deposit franchise is toast. In recent months, several big-name banks have witnessed the kind of balance-sheet spillover not seen since the Depression, with asset troubles leading first to falling capital levels and market valuations, and then sudden jolts to the liability side of the ledger as jittery customers flee in anticipation of the bank going bust.
The first significant signs of trouble came in July, when regulators seized $32 billion-asset IndyMac Bancorp, the Pasadena, CA-based mortgage lender, after customers descended on its branches in a run reminiscent of the 1930s. Disturbingly, the run continued even after the failure-evidence that in shaky times, not even deposit insurance seems capable of preventing fear and rumor from engulfing an institution.
Washington Mutual's failure and subsequent $1.9 billion sale to JPMorgan Chase was the result of regulators' desire to head-off trouble after the nation's largest thrift lost $16.7 billion in deposits-despite paying above-market rates of up to five percent-over a 10-day period. The "silent run" on Seattle-based Wamu came despite claims that it had enough capital to ride out billions of losses tied to credit-quality troubles.
"I'm surprised it took people that much time to pull their money out," says Robert Rogowski, managing director of corporate finance at McAdams Wright Ragen, a Seattle investment bank. He notes that the local press had been "crying fire" for months about Wamu's problems. Seeing the writing on the wall, Rogowski moved "everything above $100,000" out of his personal Wamu accounts in August.
Wachovia's sale was linked to deposit trouble, as well. Edward Kelly III, Citi's head of global banking, alleged in court documents that Wachovia faced an imminent shutdown after losing $5 billion of deposits in one day. "Had Citigroup not stepped up, ... Wachovia would have failed that same day," Kelly asserted. As regulators struggled to stabilize the system, other large banks, including National City and KeyCorp, also were subject to rumors of deposit flight.
The irony is that bank deposits overall have never been more attractive to customers. At the end of the second quarter, banks and thrifts held a combined $8.5 trillion in deposits, a 6.7 percent rise from a year before, according to the FDIC, and more than double the $4 trillion held in 2000. The roiling of equity markets is expected to boost their appeal at a much higher-than-average rate in the near-term, as consumers and businesses alike put safety above returns. "Right now, it's all about preservation of principal," says Gary Townsend, a principal of Hill-Townsend Capital. "Putting money into bank deposits hasn't been this attractive in a long time."
How those deposits are divvied up could be in for a significant overhaul. Even before the crisis, big banks had been grabbing a greater share of the overall deposit pie. The top 10 banks controlled 32 percent of all deposits as of June, compared to 28 percent in 2000, according to FDIC figures. That trend is expected to accelerate going forward as a result of what's happened.
Jim McCormick, president of First Manhattan Consulting Group, says that banks viewed as the least likely to fail could capture three times as many new deposits as those that are perceived as being weak. "We're going to see a significant [market] share shift to banks that are perceived as being more stable," he says. "This crisis is reshaping the competitive dynamics of the deposit business."
Winners will likely include the white knights of the crisis - BofA, JPMorgan Chase and Wells - which are positioned to become true national megabanks, with more marketing clout, products, branches and ATMs than has ever been seen in this country. JPMorgan Chase, for instance, boasts nearly $900 billion of deposits and more than 5,300 branches. Some experts predict that the new Big Three could wind up controlling half of the nation's deposits between them. "The idea of a 10 percent deposit cap is dead," Booz's McMahon says.
A handful of superregionals that have thus far dodged serious trouble, including U.S. Bancorp and PNC Financial Services Group, also stand to pick up significant share and could eventually strike a significant deal or two, analysts say. "You'll have an oligopoly - five or six major players nationwide - and they will set a sort of competitive umbrella under which everyone else competes," Senchak predicts. McMahon says those banks could control up to 70 percent of deposits within two years, "and the regulators will support that consolidation" to preserve the system's stability as banks continue to struggle with credit-quality issues - and now, recession.
Early returns show that the big guys are indeed picking up share. Bank of America gained $27 billion of deposits during the third quarter, a four percent jump, including $9 billion over one eight-day period. At U.S. Bancorp, which has weathered the credit storm relatively well, deposits soared by $14.7 billion, or 13 percent, for the year that ended in June. CEO Richard Davis says the trend is accelerating: In recent months U.S. Bancorp has attracted a steady stream of new deposits from the likes of city and county treasurers and corporate CFOs looking for security. "In this rather Darwinian time we've all been facing, there have been some silver linings," Davis explains. "We're seeing a real flight to quality, and getting more shots at the best customers."
The oligopoly will have plenty of competition from direct banks, such as ING Direct and HSBC, which continue to gain share via high-rate online offerings, and big foreign branch players, such as Grupo Santander, which in October bought Philadelphia's Sovereign Bancshares. Money-market funds, which after several high-profile near-death experiences, also appear to be insured, all-but negating a crucial bank advantage.
Meanwhile, the two Wall Street investment banks that didn't go under or get acquired-Goldman Sachs and Morgan Stanley - are now bank holding companies. Both already have modest deposit franchises through industrial loan corporations and are expected to jump into the fray for low-cost funding. While the two have not yet let their plans be known, Morgan Stanley CEO John Mack told employees in a letter following October's completion of a $9 billion capital injection from Japan's Mitsubishi UFJ that the company would seek to sell retail banking products through its 500 existing retail offices, and was "looking at acquisitions that might make sense for the Firm and help us ramp up our deposit base."
The erstwhile investment banks "have two choices," says Bob Meara, a senior analyst with Celent. "Either totally blow out their online and mobile banking channels or find some good banks to buy." Adding more de novo branches to a saturated market "would be out of the question," he adds.
Smaller regional and community banks could have trouble dealing with the new environment's dynamics. The crisis' impact on deposits will hasten the industry's evolution into one dominated by large banks and a limited number of "specialized" community banks, McMahon argues. Some regionals might survive, but the era of the corner bank that takes deposits and makes commercial real estate loans without a well-defined niche - a business expertise or an ethnic emphasis, for instance - "is fast-disappearing, and tougher competition for deposits will make it disappear even faster," he says.
"It will be like New York City on every Main Street. You'll have a bank next to you with a big brand and national access to your money," McMahon adds. "That's very tough to compete with."
Camden Fine, CEO of the Independent Community Bankers of America, disagrees. People who predict the demise of the traditional community bank "have never driven down Route 19 in central Missouri," where folks have a strong affinity for their local institutions. In fact, he says, the crisis has boosted deposits in many community banks. "At least currently, people are wanting to keep their money close to home. They're flocking into the local Farmers & Merchants Bank."
Some other industry observers also predict that community banks will make significant deposit gains in the wake of the big-bank deals. Wamu, for instance, attracted customers by being an anti-bank with a casual aura and "Woo-Hoo" marketing. "Now those branches are going to be run by three-piece suit guys [JP Morgan Chase]," says one consultant. "There are much higher-than-normal odds of deposit attrition. That plays into smaller banks' hands." McCormick predicts some smaller banks will employ "pinpoint, attacker-type marketing to shake the tree and catch the fruit that's less tightly attached."
Even so, Fine concedes that if the crisis continues, safety-and-soundness concerns could lead to more customers taking their deposits to the perceived safety of a large-bank balance sheet. The FDIC boosted deposit insurance limits to $250,000 in September, trying to staunch outflows at smaller and less-stable banks. But the longer the system remains unstable, he says, the more at risk their deposit market shares will be. "My greatest concern is that the government has created two classes of depositors: one [with megabanks] that's totally protected, because those institutions are too-big-to-fail, and a second class who put their money in community banks," Fine says. "If one of those banks happens to fail, anything over the deposit-insurance limits, they'll take a hit on it." Fine says his group is planning to lobby Congress to "break up these big firms. They've made the system more risky today than it was going into the crisis."
The stakes are high. The cornerstone of customer relationships and cross-selling efforts, deposits also are the biggest source of fees for most banks. Banks that do best at generating them organically make more money over time-and, by dint of that earnings strength, garner higher valuations, McCormick says. FMCG studies have found a 65 percent correlation between branch-based deposit growth and total shareholder return. "A strong retail deposit business is the crown jewel of banking," he says.
And that's during good times. The credit squeeze has made loan pricing more attractive than it's been in a long time, promising nice net interest margin bumps for savvy lenders with funding to spare. With little securitization activity to speak of and scaled back wholesale funding options, traditional balance sheet lending has become fashionable once again -making deposits more coveted than ever. "If you're a customer with deposits, you now represent three times the traditional profit you used to represent, because of the spreads on the lending side and the stability," McMahon says.
Meara says banks that aren't too preoccupied with credit problems have almost uniformly made deposit gathering a higher priority. Many are pushing out remote deposit capture technologies ahead of schedule - giving away scanners and offering free trials. They're also adding more "deposit-gathering specialists" to their payrolls and shifting incentives for branch managers to emphasize deposit growth.
"Even a year ago, the strategic posture was defensive: ‘I don't want to lose my good customers to some big bank.' Today, there's a lightning race to the market in an offensive way," Meara says. "There are clear, executive-level mandates to grow deposits in ways we haven't seen before."
Pricing competition has already picked up in many markets and is expected to become more intense. Some smaller and mid-sized banks have begun advertising high-yield savings products in local newspapers. In Minneapolis, TCF Financial Corp. recently ran full-page spreads for savings accounts that pay as much as 3.76 percent. "As long as the stock market remains fragile, people will put a lot more money into banks and want it to generate higher yields," McMahon says. With loan rates high, "why skimp on what you're paying for deposits and save 70 basis points when you're losing 300 basis points on the lending side?"
The implications of the present shakeout won't be fully understood for years, but it seems clear that the competition for deposits will be more intense in the years ahead. Is your bank ready?